Avoid Private Equity Debt
"To be in retail now, you need to be unique; you need to offer something you can’t get online. And typically private equity firms tend to cut back,” Josh Kosman, author of The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis, told BuzzFeed News. “They’re not improving their stores and their product lines because the companies they buy have so much debt. So they’re not well-positioned to survive Amazon. And the consequences are, if revenue continues to fall, ultimately they will probably collapse.”
Buzzfeed, Leticia Miranda, “How Wall Street Bought Toys ‘R’ Us and left 30,000 People Without Jobs”, April 27, 2018
The retail business is undergoing severe disruption as indicated by the latest bankruptcy of Toys ‘R Us. Toys ‘R Us was bought by a private equity firm sometime during the mid-2000’s when the retailer was struggling and sought out a new owner, got loaded up with debt in the process, and now, in the face of Amazon, can’t generate enough revenue to get out of debt. The premise behind the theory of loading up on debt, at least when I was younger, was that such onerous debt was supposed to concentrate management’s mind on finding solutions to improve the business. If the business improved, management was supposed to be rewarded handsomely. The problem is the debt sometimes can get too onerous that there is no way out and the private equity firm takes out cash as management fees in the interim, thus not helping matters. My impression of this practice is that the results are mixed: some successes and some failures. And during those failures, the private equity firms generally do not come out of it hurt like the employees.
Now that we are facing gale winds from the new technological revolution, using private equity firms and high debt loads is not advisable because any cash your business can generate must go toward improving the business, research and development, and employee skills improvement rather than toward private equity management fees and repaying debt. The private equity firms do not know your business so paying them management fees is useless. As for debt, it’s one thing if you load up on debt directly and used the cash from the loan to improve the business. It’s another to get loaded with debt by a private equity firm and you can’t use that cash because it has been used by the private equity firm to buy up your business, not to improve your business. Instead, if you can, you probably would be better off getting the debt yourself to use toward specific improvements and use the private equity firm as your consultant to guide you on how best to use that loan. Of course, I doubt they would go for that because they wouldn’t get the maximum benefit that way.
Whatever your situation may be, it would not be a good idea to get in business with a private equity firm because you can’t afford that empty debt (you just get the burden of repaying it but you can’t use that cash to improve your business), not during this technological revolution that is affecting all industries. Debt from private equity is a bad strategy in this environment.
